The Growing Gap Between Productivity and Earnings

By Jared Bernstein and Lawrence Mishel

[DRAFT, October 4, 2006]

[Weve benefited from comments from Jason Furman, Peter Orzag, and Dean Baker.
Robert Gray provided research assistance. Any mistakes are our own.]

On July 13, President Bushs chief economist, Edward Lazear, presented a paper before
this very body entitled A Success Story: American Productivity.1 More recently,
Federal Reserve Governor Randall Krosner praised the productivity resurgence.2 We too
have joined the cheering section. In the introduction of our most recent version of State
of Working America, we call the faster productivity growth regime of recent years an
unequivocally positive development for the economy and note that along with the first-
order benefits of higher output per hour:3

the productivity acceleration has produced ancillary benefits. One key example of
such a benefit is the fact that Federal Reserve officials view faster productivity growth as
forestalling inflationary pressures, thereby enabling them to pursue more accommodating
monetary policy than would otherwise be the case. Research suggests that these dynamics
themselves will lead to longer and less volatile business cycles, an obviously positive
development.

However, unlike these other economists, we are troubled by a development that Lazear
and others seem too quick to dismiss: the large and growing gap between productivity
growth and compensation, wages, and incomes. In our view, their analysis of this issue
downplays what we view as a significant economic challenge of the day, one that policy
makers should recognize as deserving of attention and action.

1
http://www.whitehouse.gov/cea/lazear20060713.html.
2
http://www.federalreserve.gov/boarddocs/speeches/2006/20060927/default.htm.
3
Mishel et al, 2006. State of Working America, 2006/07.
In what follows, we take a close look at the historically large and growing gap between
productivity and real wages, compensation, and income. We find that a number of
analysts have tried to steer the conversation away from a productivity/earnings gap by a)
using an output as opposed to a consumer deflator for wages, b) ignoring the increase in
wage inequality and thus focusing largely on average compensation as opposed to median
measures, c) dismissing the gap as a function of higher health care costs, and/or d) citing
lags as the explanation for the gap, and suggesting it will soon close.

We argue that none of these arguments is particularly persuasive: using a consumer

deflator, even average compensation has diverged from productivity in recent years.
Whats more, even with the same deflator, productivity and compensation have diverged
recently, meaning that the share of national income going to capital is up and the labor
share is down. Note that this describes two separable sources of greater income
inequality: greater concentration of compensation within the labor share of national
income, and a shift in factor shares from labor to profits. According to a decomposition
we present below, both of these sources of increased wage inequality explain the lions
share of the growth in the wage/productivity gap both over the long-term and in recent
years (about 60% of the growth in both cases). To ignore the role of inequality in the
productivity/wage gap is thus to divert attention from a central factor. Rising health costs
also play a role in the productivity/wage gap, but it is a minor one. And citing lags in the
fifth year of a recovery seems too much like Panglossian hand-waving.

Though presumably few workers themselves would put it this way, workers have a right
to be concerned about the large and growing gap between productivity growth and their
paychecks. They are working harder and smarter, baking a bigger pie more efficiently,
but ending up with smaller slices.

Productivity and Growth of Wages, Compensation, and Income: Growing Apart

What have policy makers and leading economists been saying about the
compensation/productivity split? In a speech earlier this year, President Bush asserted
that as the workforce is more productive, higher wages follow, that's just a fact of
life.4 In his NEC presentation, Ed Lazear, his chief economist, repeated the economists
mantra that productivity growth leads to higher wages and improved living standards.

In general, these are by no means controversial statements. Greg Mankiw, Lazears

predecessor as the presidents chief economist, recently took readers of his blog
through the theory and arithmetic behind the connection between compensation and
productivity.5 Cutting to the nub of his exposition, Mankiw made two points, both of
which we will examine: 1) if we use the same deflator, and if factor shares remain
constant, productivity and average compensation will rise at the same rate, and 2) theres
no reason to expect the median (as opposed to the average) workers earnings to rise with
productivity. Krozner (2006) added one other: though productivity and real average
compensation can and do diverge, they re-equilibrate with a lag.

The first point is an identity, and thus helps to guide the search for whats driving the
gap. The second point invokes the inequality phenomenon, discussed below. We deal
with lags in the concluding section.

Lazear offers a graph, reproduced below (Figure 1, though he omits the lower line),
showing real average compensation rising pretty much in lockstep with productivity since
the latter 1940s (Kroszner uses the same figure). But there are three problems with this
figure in the context that it is often presented, i.e., to imply that the benefits of
productivity growth are being broadly shared. First, to get these series to track each
other, you have to deflate compensation with a product price index, not a consumer
index. Second, the fact that average measures of earnings have diverged from the median
means that such figures are less representative of the typical workers experience, and
three, though its hard to see in a figure covering over fifty years, there really has a been a
shift in factor shares favoring capital in recent years, one that seems to go beyond a
reasonable explanation invoking lags.

4
http://www.whitehouse.gov/news/releases/2006/01/20060119-2.html.
5
http://gregmankiw.blogspot.com/2006/08/how-are-wages-and-productivity-related.html.
Deflating Compensation with a Product Deflator

Since Lazear is invoking the relationship between productivity and living standards, it is
not clear, nor does he explain, his decision not to use the consumer price index to deflate
compensation. It is well known among economists that the output deflator has grown
more slowly than the CPI, as the prices of investment goods (items not in the consumer
deflator) have not gone up as quickly as the goods and services we consume.

As we show in appendix table A, the difference was negligible from 1947-73, as

consumer prices rose only 0.03% faster per year than product prices as measured by
nonfarm business implicit price deflator from the BLS productivity accounts. Once
productivity slowed, from 1973-1995, the price gap grew to 0.25% per year, explaining a
bit more than one-third (36%) of the gap between real compensation and productivity
growth. Note that this is about the same share as over the 2000-05 period, when the gap
between productivity and real compensation grew by 1.71% per year. The difference
between the product and consumer deflators accounted for about a third (32%) of that
gap.

The figure also shows the compensation result Lazear would have gotten had he used the
CPI deflator (from 1978 forward, this compensation seriesreal compensation from the
BLS nonfarm business sectoruses the CPI-RS, an improved measure of consumer
inflation which grows more slowly than the CPI-U). As is clear, real compensation
grows more quickly when deflated by a product deflator. But consumers are not buying
machine tools and drill presses; they are buying gas at the pump, housing services,
haircuts, and so on, all of which are weighted more heavily in the CPI than in the product
deflator. They presumably take little solace from the fact that the prices of investment
goods are rising less quickly than consumption goods, and it is thus misleading to use a
product deflator on compensation in this context.
Of course, there is a good argument to be had about the implications of these diverging
deflators. If prices of investment goods are falling more quickly than those of consumer
goods, the implication would be one of two problems (or some combination of both).
Either we are investing in goods that are not raising consumers living standards as much
as they should be, or we are failing to pick these gains up in our consumer price
measures. These questions go beyond the scope of this study, but at the very least, it
seems that economists should not be avoiding it by neglecting to plot real compensation
as it is generally understood, especially in a discussion about living standards. To do so
implicitly assumes that the benefits from lower priced investment goods are freely
flowing to consumers, a broad, untested, and unjustified assumption.

Figure 1: Productivity and Real Compensation, Using Product and CPI Deflators

400.0

350.0

300.0

250.0
1950=100

200.0

150.0

100.0

50.0

0.0
19 -(II)

19 -(II)

19 -(II)

19 -(II)

19 -(II)

19 -(II)

19 -(II)

20 -(II)
51 I)

55 )

58 I)

62 )

65 I)

69 )

72 I)

76 )

79 I)

83 )

86 I)

90 )

93 I)

97 )

00 I)

04 )

)
53 )

60 )

67 )

74 )

81 )

88 )

95 )

02 )

-(I
19 -(IV

19 -(IV

19 -(IV

19 -(IV

19 -(IV

19 -(IV

20 -(IV
19 -(III

19 -(IV
19 -(III

19 -(III

19 (III

19 (III

19 -(III

19 -(III

20 -(III
19 0-(

19 7-(

19 4-(

19 1-(

19 8-(

19 5-(

19 2-(

20 9-(

06
-

-
5

9
19

Productivity Comp (Lazear's way) Comp (CPI)

The Inequality Wedge

The two lines that generally move together replicate those in Lazears Figure 2.6 Even
these lines, however, separate in recent years, implying a shift in national income from
compensation to profits. The profit share in the corporate sector is just short of a 40-year
high and the compensation share is at a commensurate low. As noted, some cite normal
recessionary lagsprofits tend to recover before wages as the business cycle gets
underwayto discount the importance of this recent split. There may be something to
this, but a split of this magnitude at this stage of a recovery that is probably in middle-age
at best is historically unique.

In other words, even using an increasingly unrepresentative (of the typical worker) series
of average compensation, productivity and earnings, measured from the consumers
perspective, have diverged quite sharply. In fact, since 1979, productivity has grown
almost twice as fast as CPI-RS-deflated average compensation, 70% vs. 37%.

Another important dimension of inequality is that which has been ongoing within the
compensation share of national income: the increase in wage inequality, a factor that has
increasingly come between productivity growth and the living standards of many in the
workforce. To the extent that this occurs, the economists mantra regarding productivity
growth lifting living standards becomes ever less descriptive of the typical working
familys experience.

For example, renowned productivity expert Robert Gordon concluded in a recent paper
(italics in original):7

The standard link between the standard of living and productivity growth is
broken by our finding that over the entire period 1966-2001, which encompasses
the period of the 1965-1979 productivity growth slowdown and subsequent 1995-
2005 productivity growth revival, only the top 10 percent of the income
distribution enjoyed a growth rate of total real income (excluding capital gains)
equal to or above the average rate of economywide productivity growth. The

6
Any differences are due to productivity revisions since Lazears paper appeared.
7
Robert Gordon and Ian Drew Becker, Where did the Productivity Growth Go? NBER WP 11842, Dec,
2005.
 bottom 90 percent of the income distribution fell behind or even were left out of
the productivity gains entirely.

Another Lazear figure, replicated below (Figure 2), focuses on the real hourly wages of
non-managerial workers, who roughly correspond to workers in the bottom 80% of the
wage scale, a fair estimate of the group that has been less likely to benefit from
productivity growth over the past few decades. Thus, this figure introduces the impact of
the inequality wedge between productivity and earnings of those with below average
wages. The figure shows that indeed, productivity and real wage growth do seem
correlated, although real wages appear to consistently grow more slowly than
productivity, and are often falling in real terms. In fact, only by indexing the values can
we evaluate the extent to which they have tracked each other over time.

Figure 2: Productivity and Real Wage Growth, Yearly Changes

8.0%

6.0%

4.0%
4-quarter percent changes

2.0%

0.0%

-2.0%

-4.0%

-6.0%

-8.0%
66

71

76

81

86

91

96

01

06
19

19

19

19

19

19

19

20

20

Real Non-Manger's Hourly Wage Productivity

We perform this analysis in Figure 3, which indexes the same two series in Figure 2 to
100 in the base year of 1966 (later in the paper we explain the middle two lines in the
figure).8 Productivity and real wages grow together briefly at the beginning of the figure
and then diverge quite sharply. Over the full period, productivity grows twice as fast as
real non-managerial wages.

Figure 3: Productivity and Real Non-Managerial Wages

and Compensation
230
Productivity
210

190

170 Real Non-

Manager Comp,
1966q1=100

150 IPD

Real Non-
130
Manager Comp

110

Real Non-
90 Manager Wage

70

50
1966-I 1969-II 1972-III 1975-IV 1979-I 1982-II 1985-III 1988-IV 1992-I 1995-II 1998-III 2001-IV 2005-I

Thus far we have identified three sources responsible for the split between productivity
and real earnings: the divergence between product and consumer deflators, the increase in
capitals share of national income, and the growth of earnings inequality. It is important
to recognize that two of these factors (deflators and inequality) are structural in nature;
they are not a function of the business cycle and as such, they are unlikely to soon
disappear, meaning productivity growth will likely continue to outpace the wages or

8
We use the RS deflator for wages in all figures and tables, which leads to faster wage growth from the 80s
forward than does the CPI.
incomes of many working families. Whether the shift in factor shares reverts back before
the next recession is yet to be seen.

Before we conclude, there are a few more related questions worth examining: a deeper
consideration re the role of inequality in the productivity/wage gap; the role of health care
costs; and the lag explanation.

Further Reflections On Inequality and the Productivity/Wage Gap

While we have accused those who downplay the gap as glossing over a critically
important inequity in our economy, those of us who point to the gap between productivity
and medians are guilty of our own bit of glossing: we rarely articulate why we think the
median should be rising in step with productivity. After all, the theory says nothing
about this: it is cast strictly in terms of averages. In fact, in a period wherein the average
diverges from the medianperiods of growing inequalityone would expect patterns
like that in Figure 3.

The first point to recognize is that, in fact, productivity and below-average measures once
did rise together. As Table 1 shows, if ever the economists mantra was true, it was
during the post-war years, when productivity growth handily reached the median family.
But it has not done so since, corroborating Gordons finding noted above. Between 1947
and 1973, productivity and real median family income grew in just about lockstep, both
doubling (we get a similar result with the real production worker wage, which grew by
about 90%, 1947-73). Since then, however, real median family income has lagged
productivity growth by more than 50%.

Of course, marginal product theory explains this away by assuming that every worker is
paid precisely their contribution to productivity growth at the margin, so any measure of
compensation that diverges from productivity is simply implying less productive workers
being fairly remunerated for their diminished contribution to output. But this is simply
explanation by assumption, and while we are sure theres a correlation between an
individuals contribution to firm output and their compensation, we are equally sure that
the determinants of pay go much further than that.

Bargaining power also makes a big difference, and a number of trends have served to
diminish this wage determinant over the past few decades. In this context, think of
bargaining power as the forces by which workers claim their fair share of productivity
growth. That is, in an economy with low union concentration, non-binding minimum
wages (at least at the federal level), lots of globalization and few periods of full
employment, we do not think it should be at all controversial to assert that there are a set
of forces that get between the marginal product assumption and reality. Under such
conditions, some workers are paid less than their contributions to firm output and some
are paid more.

Along with the list of institutional/structural changes regarding unions, globalization,

regulations, and minimum wages, full employment plays an important role in the
productivity/wage split. Between 1947 and 1973, when productivity and median
earnings/income were rising together, unemployment average 4.8%; since then (1973-
2005) the average was 6.3%. Yes, lots of influential demographic changes took place
over these years that play a role in this difference, but it is very important to recognize the
importance of the latter 1990s in the context of the productivity/wage discussion. The
unemployment rate in these years headed for the 2000 rate of 4%, the lowest in 30 years.
Inflation decelerated over this period1995-2000and wages for workers throughout
the pay scale rose with productivity growth.

Between 1995 and 2000, real hourly wages at the 20th percentile grew at a yearly rate of
2.3%, just about the same as productivity (2.5%). Compare this to the same period in the
1980s, i.e., the last five years of the cycle: real 20th percentile wages were flat (-
0.1%/year) while productivity rose 1.5% annually. These data are collected in Figure 4,
which also shows the unemployment rate at the cyclical peak: 5.3% in 1989 and 4.0% in
2000. Did newfound, productivity enhancing skills suddenly rain down on low-wage
workers? Much more likely, the tight labor market forced employers to bid wages up,
thus enforcing a more equitable sharing of the gains from productivity.

The last set of bars, though reflecting a different part of the cycle, show how these
variables have trended since 2000. Productivity accelerated further in the 2000s, but,
with the onset of recession and the long jobless recovery that followed, low wage
flattened, and, as shown in Table 1, median family income fell three percent. In other
words, full employment matters.

Table 1: The Growth of Real Median Family Income and Productivity, 1947-2005
Period Productivity Median Family Income
1947-1973 103.7% 103.9%
1973-2005 79.0% 22.5%
1995-2000 13.4% 11.3%
2000-2005 16.6% -2.3%

Source: Authors' analysis of BLS and Census Bureau

data.

Figure 4: Real Low Wg Growth, Productivity, and Unemp: Three Five-Yr Periods

0.06
5.3%
Annual Growth Rates and Unemp (final yr)

5.1%
0.05

4.0%
0.04
3.1%
0.03 2.5%
2.3%
0.02
1.5%

0.01
0.1%
0
-0.1%
-0.01
1984-89 1995-2000 2000-05
Low Wage* Productivity Unemp(final yr)
An interesting example of the dynamics relating bargaining power, productivity, and
wages comes from a recent New York Times article on an initiative at Wal-Mart to hold
down labor costs by capping wages, using more part-time workers and scheduling
more workers on nights and weekends.9 The article quotes a Wal-Mart executive as
stating Given the impact of tenure on wages and benefits, the cost of an associate [sales
person] with 7 years of tenure is almost 55 percent more than the cost of an associate
with 1 year of tenure, yet there is no difference in his or her productivity. Besides
contradicting the widely held and oft substantiated view among labor economists that
tenure is associated with both higher earnings and greater labor productivity, this is a
classic example of how actions taken by firms, in this case a powerful, possibly
monopsonistic employer, can lead to a split between productivity growth and earnings.

And note that the split occurs at a highly influential, profitable, and productive firm, one
with over one million workers. It is also notable that Wal-Marts wage setting does not
allow market forces to determine wage levels as marginal product theory would dictate,
but by fiat (wage caps) and hiring strategy (boosting the part-time staff, and trying to
avoid older workers).

We would argue that these types of wage setting dynamics violate marginal product
theory on a daily basis, placing a growing wedge between productivity growth and the
median wage. The absence of full employment, greater union power, higher minimum
wages, and large flows of cheap immigrant labor also provide an opening for actions like
these to occur. We are not claiming that were policy makers to turn this around, real
medians would grow in step with productivity. But history unequivocally shows that the
gap would be significantly diminished.

The Health Care Cost Wedge

9
Wal-Mart to Add More Part-Timers and Wage Caps, NYT, October 2, 2006, pg. A1.
Many analysts, including Lazear, endeavor to explain away the productivity/wage gap by
citing the increase in health care costs. We refer readers to our earlier analysis
(Allegretto and Bernstein, 2006)10 which we summarize here.

Can rising health care costs fill the gap between stagnant real wages and rapidly rising
productivity? Surely, some amount of trading off takes place, but there are a number of
reasons why this cannot be the whole story of the gap.

First, nearly half (48%) of the workforce do not get medical coverage through their job,
so there can be no tradeoff for these workers. For workers earnings less than $15 per
hour, the share without medical coverage is 62%.11 Also, as Allegretto and Gould (2006)
show, the wages of those least likely to receive employer provided health coverage have
fallen most quickly since 2000.12

We make this point graphically in Figure 5, using data from Goulds analysis of recent
changes in employer provided coverage. The first bar in each group shows the real wage
growth at the 10th, median, and 90th percentile, 2000-05. The second bar shows the share
of workers with employer-provided coverage in the bottom, middle, and top wage
quintile. The wage/benefit tradeoff would predict that the wage part of compensation
would grow most quickly for workers least likely to have employer coverage (since those
workers would be least likely to trading away wage gains for more benefits). In fact, the
opposite has occurred. Wages grew most quickly for those who started the period with
the highest level of coverage.

Figure 5

10
http://www.epinet.org/issuebriefs/218/ib218.pdf.
11
See table 2: http://www.bls.gov/ncs/ebs/sp/ebsm0004.pdf.
12
http://www.epi.org/content.cfm/webfeatures_snapshots_20060412.
 Share with Employer-Provided Health Coverage, 2000, Not Correlated with Real Wage
Change, 2000-05

100.0%

90.0% 87.7%

80.0% 76.7%

70.0%

60.0%

50.0%

40.0%

30.0% 28.3%

20.0%

10.0%
4.8%
2.9%
0.5%
0.0%
Low Middle High

Source: Authors' analysis of Gould, 2006 Real Wage Health Coverage

Second, employers health care costs decelerated quite steeply over the very period when
compensation and productivity were diverging. Employment Cost Index data, for
example, show that employer health costs went from 10.5%, 2001q1-02q1, 9.8% through
2003q1, and steadily slower to 5% in the first half of 2006, in part because rising costs
have led to less coverage (Gould 2006).13

Finally, as noted above, the growth of corporate profits in recent years has solidly
outpaced that of compensation as employers are trading away both wages and benefit
increases for higher profits.

Decomposing the Gap

The second line from the bottom in Figure 3 shows that including health care costs closes
only a small part of the gap for non-managerial workers. Since no time series on median
or non-managers compensation is available, we derive these values by multiplying the

13
http://www.bls.gov/ncs/ect/sp/echealth.pdf.
real value of the non-managerial wage by the ratio of NIPA compensation to NIPA wage
and salary values. For example, in the second quarter of this year, that ratio was 1.241,
so the real wage in that quarter goes from $16.64 to $20.65 as a measure of average
compensation.

The third line from the bottom shows what happens if we deflate the non-managerial
consumption wage with the product deflator (we use the implicit price deflator from the
productivity accounts, as in Figure 1). Again, the gap is diminished but not closed.

These different measures allow a crude but instructive decomposition of the productivity
wage gap. Focusing on Figure 3, the gap between the bottom and top lines represent the
productivity/real wage gap. The gap between the bottom and second line is the share due
to fringe benefits; the difference between the two middle lines is due to the deflator
difference, and the rest we assign to inequality. Note that this combines both sources of
inequality: the increase in concentration within the labor share and the shift from labor to
capital. We can thus further decompose the contribution of these two components using
average compensation deflated by the product deflator (this is the same series shown to
be generally rising with productivity in Figure 1). Here, the difference between
productivity growth and the product-deflated average compensation is assigned to factor-
share shifts and the rest is assigned to earnings inequality within labors share. Based on
these approximations, we can decompose the contributions of these difference factors
over different periods.

Table 2 provides the results, giving annualized rates of change for the full gap and its
components over various time periods. From 1979-2006, inequality explains the lions
share of the gap, about 3/5s (1.16%/1.94%). Most of that 1.16% annual increase is due
to greater earnings inequality within labors share. Deflator differences explain about
one-third, and fringes are a small contributor. Turning to some instructive sub-periods,
fringe benefit costs, which actually fell in real terms in the latter 1990s, led to a smaller
gap, and inequality played less of a role as well. In the current period, inequality explains
more than half the gap, and interestingly, it is divided evenly between factor share shifts
and earnings inequality. Note also that the contribution of inequality to the productivity
wage gap in the 2000s was three times that of the latter 1990s (1.76% vs. 0.56%).

Given the importance of the productivity/wage gap in the current economic debate,
Figure 6 plots the gap components since 2000. Note that since 2003, each component has
been flat, and the increase in the gap has come exclusively through greater inequality.

Figure 6

Figure 6: Productivity, Wages, Comp: Non-managers,

2000-06
125

Productivity
120

Real Average
115 Comp, IPD
2000q1=100

110
Real Non-Manager
Comp, IPD
105
Real Non-Manager
Comp

100 Real Non-

Manager Wage

95
I I)

I I)

I I)

I I)

I I)

I I)
)

)
-( I

-( I

-( I

-( I

-( I

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-( I

-( I

-( I

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-( I
00

01

02

03

04

05

06
00

01

02

03

04

05
20

20

20

20

20

20

20
20

20

20

20

20

20

One question about this decomposition is how we should score or think about the
deflator component. As noted above, it sounds benign, but only if we accept the implicit
assumption that the benefits of slower growing prices in investment goods are flowing
broadly to consumers across the income spectrum. It may represent measurement error
perhaps price growth of investment goods is biased down and consumer price growth
biased up. If so, correcting these biases would lower the productivity/wage gap. On the
other hand, if the prices investment goods are rising more slowly than those of consumer
goods, this could boost investment incomes relative to consumer incomes, and would
thus constitute another dimension of growing inequality (in which case, the inequality
estimates in our decomposition are biased down). At any rate, the distributional aspects
of the deflator divergence have not, to our knowledge, been examined. Surely, this is an
area where more research is needed.

Table 2: Decomposing the Productivity Wage Gap, Annualized

Changes
1979-2006 1979-1995 1995-2000 2000-2006
Full Gap 1.94% 1.94% 1.29% 3.11%
Benefits 0.14% 0.12% -0.43% 0.64%
Deflator 0.64% 0.61% 1.16% 0.72%
Inequality 1.16% 1.21% 0.56% 1.76%
Factor Shares 0.17% 0.29% -0.85% 0.90%
Earnings 0.99% 0.92% 1.41% 0.86%

Source: Figures 3, 6, and text.

But Isnt This Just About Lags?

When asked about the productivity/wage split, Lazear and others often cite lags,
suggesting that it is just a matter of time before productivity growth starts trickling
down.14 Like the marginal product argument, this one cant be disproved, since one can
also cite lags as an explanation for why something that we think should have occurred
has yet to do so.

Such a claim would be a lot more comforting if productivity and real wages had generally
been linked over the past few decades. But in an era with weakened distributional
institutions (less union coverage, low minimum wages, large trade deficits), where labor
market slack is the norm and full employment is the exception, it is unlikely that the
median wage, or the wage of non-managerial workers, or the wages of the 70% of the
workforce that is non-college educated will consistently rise with productivity. With the
brief exception in the full-employment period of the latter 1990s, these workers earnings
have not done sorisen at the rate of productivity growthin a generation.

14
See Coming of Age, Allan Hubbard and Edward Lazear, Wall St. Journal, October 2, 2006.
It should also be noted that we are in the fifth year of a recovery that began in late 2001.
Commentators citing lags need to be more explicit as to how much time they expect it to
take before productivity growth starts reaching more persons in the workforce. Without
such benchmarks, the lag explanation rings hollow. One can always urge patience, but,
as one commentator recently noted in discussing the growing gap between growth and
living standards in this recovery, for too many workers, economic growth in this recovery
has been a spectator sport.15

Conclusion

Like every card-carrying economist, we lavishly praise the post-1995 acceleration in

productivity growth, and happily note the further acceleration post-2000. At the same
time, numerous economists, including ourselves, have been busy analyzing the gap
between productivity and real wage, compensation, and income growth, a gap that has
expanded in recent years. Explanations for the growing gap range from allegedly benign
sources: time lags, as the recovery has taken an unusually long time to reach many in
the workforce and the differing growth rates between product and consumer price
deflators. A less benign source generally agreed to be playing a role is the increase in the
inequality of economic outcomes.16

One way to erase the gap over certain periods is to use a product deflator on
compensation, but there a numerous problems with this. First, it simply masks the fact
that the prices of investment goods have been rising less quickly than those of
consumption goods, and this is a real problem in discussions of living standards. It may
be strictly a measurement problem, but the debate is not well served by ignoring it.

15
Paul Krugman, Left Behind Economics, oped, New York Times, July 14, 2006.
16
One other benign explanation weve seen raised is that as the economy expanded in the 2000s, less
productive workers have entered the workforce, dragging down wages but not productivity growth. This
doesnt square with the employment rate trends over this period. Employment rates rose, especially among
the least advantaged in the latter 1990s, when the gap grew less quickly. In the 2000s, with an expanding
gap, employment rates have been slow to recover (and still remain below their cyclical peak). Also, its not
clear why productivity growth would have accelerated in the 2000s if less productive workers were
entering the job market.
Second, if those benefiting from the slower growth of investment goods are concentrated
among higher income households, this deflator difference is reinforcing the growth of
inequality.

Third, a period of both rising inequality and diminishing employer coverage of health
care and pensions, an analysis that focuses solely on average compensation is
increasingly unrepresentative of the typical working familys experience. And finally,
since 2000, even using the same deflator, average compensation has grown more slowly
than productivity growth, implying a shift in factor shares to capital from labori.e., in
recent years there are two dimensions to the productivity wage gap: a shift toward more
inequality within the labor share of national income, and shift in national income from
labor to capital.

We show that this increase in inequality has played an integral role in the productivity
wage gap. A simple decomposition suggests that perhaps three-fifths of the gap the
evolved between 1979 and 2006 is attributable to this factor alone. The same measure
reveals that the gap grew 1.3% per year in the latter 1990s and is growing at a rate of
3.1% in the 2000s. We also note, taking a long-term historical view, that this wasnt
always the case. In the post-war years, productivity and median family income, for
example, both doubled.

We urge policy makers to take these findings more seriously than they have thus far.
Obviously, such concerns become obnoxiously amplified in these politically heated
times: to suggest that a problem exists has become a sign of weakness to be exploited by
your opponents. But the productivity/wage split is a truly fundamental problem, one that
strikes at our basic sense of fairness. When the benefits of growth are not fairly shared, a
key tenet of the American dream is violated.
Appendix

Table A1
How Much Does the Price Gap Explain of the Prod/Comp Gap?
(annualized growth rates)

Share Attributable to:

Price Gap (RS- Other
Year Prod/Real Comp Gap IPD) Factors
1947-73 0.16% 0.03% 0.13%
1973-2005 0.75% 0.41% 0.34%
1973-1995 0.68% 0.25% 0.43%
1995-2000 0.08% 0.94% -0.85%
2000-05 1.71% 0.56% 1.15%

Source: Authors' analysis of BLS data.

All values are for the nonfarm business sector (except the CPI-RS). The first column
shows the difference in the annual (log) growth rates of productivity and real
compensation. The second column shows the difference between the growth of the CPI-
RS and that of the implicit price deflator, the output deflator used in the productivity
accounts. The third column shows the rest of the total gap (column 1), explained by the
other factors, including changes in underlying factor shares between labor and cap.